ICELAND SCENESTTER FOR TREASURY DAS ERIC MEYER'S VISIT

UNCLAS SECTION 01 OF 02 REYKJAVIK 000058

STATE FOR EUR/NB
TREASURY FOR ERIC MEYER AND LARRY NORTON

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: PGOV ECON EFIN IC
SUBJECT: ICELAND SCENESTTER FOR TREASURY DAS ERIC MEYER'S VISIT


1. (SBU) Summary: Since your previous visit three months ago,
you'll find many changes in Iceland's economic and political
landscape. Businesses are hurting and unemployment has risen to an
unprecedented ten percent. Currency restrictions imposed in
December were extended another six months until September 1. News
is not good on aluminum and fish, the two export-oriented pillars
that are helping to prop up the ISK. Following the escalating
protests in January, the government fell and a leftist coalition was
established. Consequently, you'll be meeting a few new faces at the
Ministries of Finance and Business Affairs and the Central Bank. As
the IMF team found during their recent visit, the political turmoil
has delayed dealing with crucial issues like resolving IceSave
account guarantees. Pressure is rising on the Central Bank to lower
interest rates, while the public's desire for EU membership and Euro
adoption has deflated somewhat, with only the business community
strongly advocating this move. The parties in the interim coalition
government are acting cautiously, knowing their actions today
directly affect whether they will be elected in general elections
slated for April 25. The vital question of how the Icelandic
economy will adapt to the new global economic realities remains
unclear. End Summary.


2. (SBU) The economic situation in Iceland has visibly deteriorated
since December. Unemployment is currently at 10.3 percent, a
dramatic rise from under two percent just five months ago. When you
were last in Iceland, there were anecdotal claims that up to 70
percent of businesses were technically insolvent because the
depreciating ISK had ballooned their foreign currency loan payments.
That has proven to be the case. In addition to vacant construction
sites with half-finished projects, a walk down the main shopping
street in Reykjavik reveals newly vacant storefronts from failed
businesses or desperate posters for final sales. Other signs of the
hard times include Baugur, one of the biggest holding companies in
Iceland, declaring bankruptcy and the Financial Supervisory
Authority's takeover of investment bank Straumur-Burdaras on March

9. The temporary capital controls that expired March 1 were
extended an additional six months. The ISK is being helped by a
small trade surplus, although the two main pillars for exports,
aluminum and fish, have suffered in the global downturn. Worldwide
aluminum demand has dropped, and the resulting price decreases have
slowed production at the country's smelters. The reduced demand for
fish has fisherman storing their catch; we hear reports that the
freezer capacity is nearly maxed out.


3. (SBU) The public discontent over the economic situation and the
government's apparent lack of action led to a series of escalating
public protests. As a result, the centrist government fell in
January, and a leftist interim coalition was put in place. The most
relevant Cabinet changes to your visit are the new Minister (and
Permanent Secretary) at the Ministry of Finance, a new Minister of
Business Affairs, and a new Prime Minister. Minister of Business
Affairs Gylfi Magnusson, whom you will meet, is a non-political
academic educated at Yale. Upon installation of the new government,
the Central Bank leadership structure was changed which resulted in
the hire of a Norwegian interim Bank Director. The Board at the
Financial Supervisory Authority was also changed, with another
academic appointed as Chair.


4. (SBU) As the IMF team found during their two-week visit that
ended last week, the political turmoil has delayed dealing with
crucial issues like resolving the dispute with the UK and other EU
countries over deposit guarantees for the IceSave accounts. The
interim coalition is acting cautiously, knowing their actions today
and the public perception of those actions will directly affect the
outcome of the April 25 general elections. Inconclusive public
opinion polls have given the parties little ground to feel
confident, and they are watching every move carefully. As an
example, one of the first acts of the new Minister of Health was to
reverse the unpopular cost-cutting decision of his predecessor to
close a small hospital, despite the fact that his Ministry is under
the gun to make nearly ISK 7 billion ($60 million) in budget cuts.
There is pressure on the Central Bank to lower the prime index rate.
However, public calls to join the EU and adopt the Euro are not as
intense as in October. Only the business sector continues to
advocate this position; the latest poll indicated 54.5 percent of
the general public were against joining the EU.


5. (SBU) The change in government has also loosened tongues and
you'll find many interlocutors are offering details of the situation
leading up to the banks collapse. The government was criticized
for not investigating criminal activities within the banks and the
international corporations, and as a response French-Norwegian
anti-corruption crusader Eva Joly has been hired as a special
government consultant for the investigation of economic crimes.
Mysterious leaks to the media of the banks' loan books are revealing
that the banks' owners were manipulating their stock prices and that
the quality of loans (previously touted as sound) deteriorated

REYKJAVIK 00000058 002 OF 002


before the collapse.


6. (SBU) Comment: Installing new experts in key positions such as
the Central Bank, the Financial Supervisory Authority and some
ministries, is positive and will provide needed expertise. However,
given that the interim government is acutely aware of the impending
April 25 general elections, it is unclear how much progress will be
made before a new government is installed. The vital question of
how the Icelandic economy will adapt to the new global economic
realities remains unclear. End Comment.



VAN VOORST